Making the Right Transportation Modal Decision

As relevant today as when it was published in 2005 is a paper by Lovell, Saw, and Stimson in which they discussed the "danger of making supply chain decisions based on marketing groups as opposed to supply chain characteristics."

One of these characteristics is that supply chains are likely to include a mix of finished goods and parts needed to complete goods. Hummels and Schaur published a 2012 study that found parts and components have a time sensitivity 60 percent higher than other goods.

It's important to keep in mind that supply chains are not monolithic even when considering the impact of macroeconomic factors on an entire situation. For example, looking at the whole picture of where production takes place around the world, we can see, as Hummels and Schaur pointed out, that when cheaper, more efficient air freight prices arrived, the response was to fragment production. In addition, although air is 6.6 times more expensive than ocean freight on average, the use of air freight has grown 2.6 times faster than the use of ocean freight.

Slow boat from China

Transportation-mode selection is a tactical and strategic decision. For example, shipping, while inexpensive, isn't a realistic solution for electronics components.

Time-in-transit premium
The rise in air freight use can be understood in the context of realizing that items in transit are by definition not available for use and therefore a drain on capital. Hummels and Schaur stated that every day the product is in transit adds 0.6 to 2 percent to the value of the goods.

A firm grasp on world response to such macroeconomic factors as air freight pricing is important. An example of paying close attention to macroeconomic signals would be watching shipping capacity trends using Harper Peterson & Co.'s Harpex and the Baltic Exchange's Baltex.

An example of paying close attention to supply chain characteristics is understanding that some products in the supply chain will have greater sensitivity than others to what Hummels and Schaur call the "price elasticity of demand and the value that consumers attach to fast delivery."

In a portfolio of products there can be many characteristics, and supply chain segmentation is one way to practically and effectively manage this. One useful and practical method for developing such an understanding is knowing the product value density (PVD) of the items in your supply chain. PVD is calculated simply by dividing the product value by its chargeable weight (see Lovell, Saw, and Stimson).

Cost estimation
The resulting values can then be positioned on a chart and seen in relation to the total landed cost (including the cost of capital, cost of transport, and any other associated costs) to identify whether the modal selection was in fact the most profitable or not. A small, light, but expensive product will have a high PVD, and therefore is more suited to air freight, whereas large, heavy, and cheap products are more suited to sea freight.

This is a very useful exercise to complete, as it can immediately identify cases in which arbitrarily assigning products to one transport mode or another can hurt cost-effectiveness. Utilizing just one transportation route per product isn't always the answer. A combination of routes and modes can be the optimum solution for products for which PVD doesn't indicate an obvious modal choice.

For example, if demand fluctuates above a certain level, why not meet the base requirements through bulk sea freight while meeting any fluctuations with quicker air freight shipments when necessary? In this case, air freight doesn't mean emergency or express shipments. Rather, it means planned supplementary shipments that are made possible through ensuring that understanding of processes exists throughout the supply chain, the signals are defined, and the supply chain is geared up to dispatch products through each logistics route (i.e., stock is available in the shipping location, and systems and processes are set up in order to manage the multiple modes of transportation being used).

Ensuring that processes are set up and the risk of delay is managed are vital. Multimodal transport can lead to increased risk as products are transferred from one mode to another.

Decision cost
We are all at the mercy of myriad variables and macro factors. The list includes fuel prices, economic fluctuations, natural disasters, consumer sentiment, freight capacity and more. Logically, each of these elements should be factored into total landed cost equations when choosing transport modes.

What's more, total landed cost isn't purely financial. In addition to the tangible costs just noted, there are intangible costs comprising, to name a few, time to market, first-mover advantage, consumer opinion, brand image, and out-of-stock events.

When considering the landscape of both tangible and intangible costs, we need to ask such questions as, "Does the cost of holding safety inventory as well as the inventory in transit outbalance the savings from not using air freight?" Another question to ask is, "Do actions taken to make the supply chain 'greener' mean we must source only locally?" The answer, and the opportunity to mitigate the risk of limiting the supply chain to local sourcing, could come from improving awareness of demand signals.

Choosing postponement and in-transit customization are additional ways we can optimize transport. And allowing the unloading of containers at ports, customizing to local market characteristics, and rerouting shipments based on market needs are all methods that increase flexibility.

Creating more visibility in the supply chain between partners is also crucial. Presenting partners with real, accurate, and trustworthy information can make the supply chain more cooperative, more reliable, and no longer reliant on urgent shipments. This approach can bring us closer to using the slower, better-optimized transport that the World Economic Forum in 2009 identified as a key opportunity for decarbonizing the supply chain. It isn't always the speed that is important; it is the reliability!

From a risk-management strategy point of view, it is important to understand how the supply chain can be "adapted for the arrival of climate change and environmental agreements and regulations." It should also be remembered that the supply chain doesn't end at the consumer. Obligations connected to the Waste Electrical and Electronic Equipment (WEEE) directive and similar regulations mean that "return" becomes a mandatory consideration.

What next?
Within supply chains everything needs to be available more quickly than ever before, with the urgency placed on speed to market. This shouldn't be achieved through neglecting other important areas such as transport route and mode selection.

The mode of transport can offer competitive advantage, too, with the ability for organizations to increase profit margins through carefully optimizing their mode selection based on product and segment characteristics and classifications.

I think in the case of Domestic Airlines the Hub-Spoke model just did'nt cut it anymore(anywhere in the World).

For International Flights though some Major Global Carriers[Emirates, Qantas, Singapore,Etihad,Qatar,Thai,BA,JAL] are basing their Entire Strategy around Hub-Spoke Model where they offer Ticket prices much lower than Direct Carriers.

That works in some cases particularly since most of Africa,South Asia, Southern/Eastern Europe do not have Quality Airlines with A Good Range of Destinations today.

"Getting the inventory at right time and right amount is most crucial. Keeping the inventories low and demand high is the key for profit."

@Himanshugupta: Just to add to it, "at the right place" is becoming equally important as companies move towards decentralized warehouses where your suppliers deliver directly to your local warehouse or even directly to your customers and you don't have to move the inventory around yourself. With the help of better forecasting and planning, companies are able to make this happen.

"Atleast in the case of Air-Cargo its Okay (and relatively easy)to Shift the Traffic elsewhere (to a less populated/Less Developed region) without much Hassles;but with Passenger Traffic lot more Variables are involved"

@Ashish: Exactly. And Southwest was perhaps the first airline to realize that people are not like Cargo. They don't want to travel through the hub and spoke model and would rather move from point to point. The airline was able to achieve this at the same time keeping the prices lower than those airlines operating on the H&S model.

Transportation is a big part of both supply chain and overall cost of the product. Getting the inventory at right time and right amount is most crucial. Keeping the inventories low and demand high is the key for profit.

But then,if you track Infrastructure Spending closely;you would also have noticed that Its very expensive to Start,Run and Maintain Large-scale Infrastructure Projects (like Airports and Seaports);if there is no Scale.

Best example today is Spain(and in the near future-China).

So many independent regions there tried to build their Own Airports without first figuring out which Airline is going to fly there and for what?

A lot of complementary Skills and resources are required(in addition to scale) to make sure such Large-Scale Infrastructure Projects make money and pay for themselves over time.

Atleast in the case of Air-Cargo its Okay (and relatively easy)to Shift the Traffic elsewhere (to a less populated/Less Developed region) without much Hassles;but with Passenger Traffic lot more Variables are involved.

"When it comes to Cargo Transportation you need a Hub and Spoke Model [Where the Spokes are usually Railways and Roadways] to make things more efficent."

@tech4people: I am a big fan of the hub and spoke model too and many companies have utilized it to achieve operational efficiencies. However, it an only work when you have a large number of destinations scattered across the country. If the volume is not there, it would make more sense to do direct transactions between points rather than hub and spoke model.

Apart from all the direct inventory related costs such as transportation and freight costs, there's also an opportunity cost associated with making the inventory arrive quicker than it's needed. If the inventory arrives earlier than you need it, normally you need to pay for it earlier as well. Hence, the opportunity cost here is the alternate way the business could have used those funds in something more profitable rather than paying off the supplier.